McKesson Benefits as the Population gets Older

An aging population unfortunately means a sicker one. No matter how far the boundaries of human life expectancy the final years of life tend to be ones of greater disease. Also, it seems to be easier to keep people alive longer, but not healthier. So the increasing life expectancies mean that people stay sicker longer. It seems really depressing, but it is not that bad. Very often simple treatments fight off the most common ailments. Other chronic diseases can be easily managed, and only a few lead to drastic declines in the quality of life such as aggressive cancers. On the whole living longer has been good for most people, and it has been good for McKesson Corp. (NYSE: MCK). As the overall population shifts to an older demographic McKesson should do even better.

McKesson has an exceptionally low margin business with profit margins at 1.34% for the quarter ending September 2012. Revenue ttm is at $123B, and net income ttm is at around $1.6B. That gives a nice picture of just how much profit McKesson makes off the enormous amount of sales. This is chronic, and looking at 10 years of profit margins it has always been in the low 1%s and more commonly slightly below 1%. It is also common in the industry with 1% being the common mark. One of the competitors that has a 2% margin, McKesson just agreed to buy. I am talking about PSS World Medical Inc. (Nasdaq: PSSI), which McKesson agreed to buy at $29 a share.

The earnings call mentioned that it expects $100M in synergies after 4 years. Obviously, that focuses on one narrow aspect of the acquisition but it is a start. With the purchase comes increased business and reach. McKesson is pretty aggressive about acquisitions so you should see more of that. Acquisitions are always a good time for entry unless it is poorly thought out. McKesson is not overreaching with this acquisition. It has the framework in place to absorb the new organization.

Focusing more on the long future, I know certain individuals with chronic issues that are customers of McKesson Home Care. it basically amounts to periodic deliveries of items the sick person needs. Most people are familiar with the drop shipment of diabetic supplies, but this is for conditions resulting from other illnesses like cancer. All the special needs of the patients are delivered to the house, such as specialty food and dental care supplies. In some situations a standard toothbrush is out of the question, and they make something for that.

Cardinal Health, Inc. (NYSE: CAH) is the slightly smaller competitor to McKesson. If you are looking for long-lived safety McKesson would be the standard choice, but Cardinal is better if dividends are sought considering the timescale of a demographic change. This might just stem from it being less well-known or from some other factor not readily noticeably in the fundamental metrics.

Cardinal has similar financial metrics just with certain absolutes being lower, because Cardinal is smaller. The profit margin is right around 1%, and net income ttm is $1.103B off revenue of $106.65B. Overall the company looks similar to McKesson. It commands a lower P/E at around 12 versus McKesson’s 14, but I would not look to this to provide value. Cardinal’s one positive that puts it over McKesson instead of a tie or slightly worse is the dividend yield. Cardinal has a 2.7% yield while McKesson has a 0.9%. It really comes down to the position the investment would play in a portfolio. Obviously the yield is not that great for a portfolio that is dividend focused. The yield gets a bit more weight because waiting for an aging population to get sicker and need the medical supplies these companies provide might take some time. These are not drug companies so if a pill solves the issue, these companies will not benefit as directly. There are tons of pharmaceutical companies, but a national company that sends syringes, bandages, tubing, etc. straight to the house is rarer.

That means the time period for these two companies to start seeing sales increase is pretty long. If accelerated growth is down the line getting a dividend in that time sweetens the deal with Cardinal. However, with McKesson’s sometimes aggressive acquisitions it might be in a better position to grab more of that growth. Usually more demand is great for every company in that industry, but if you have to pick between two companies in the same industry the choice gets a bit more complex.

McKesson and Cardinal are not so different. Cardinal might be a bit smaller, but overall both companies are similar. If demand accelerates, and this comes with little warning despite people in general expected to be older then who will be in the position to fill the increased demand. It takes a long time to build production capacity especially in the medical field with its rigorous regulations and standards.

Each of these companies has other businesses, but I wanted to focus on the expected demographic shift that is coming. There is no doubt that people will get older and the average age will increase. McKesson operates in many countries with the demographics shifting. There is also McKesson’s billing and financial services unit, which seems interesting. Outsourcing billing is already very common and there are companies that could step into that easy even if they are not currently in the healthcare field. That is why I wanted to start with the demographic shift. There are very few guarantees, but the population will get older. It is my opinion that as the population ages McKesson and Cardinal will see more sales. McKesson is my favorite though, because I like the strategy of consistent acquisitions. I think McKesson will be better suited to the future. I might touch on the companies again and look at ventures more removed from demographics.

Note: Also on Motley Fool here.